Ten Year Nominal-Real Treasury Spread Now at 2%

The spread between nominal 10-year treasuries (data) and 10-year TIPS (data) has increased to about 2% this week, up from almost 0% at the beginning of the year. The 200 basis point spread is still below the 250 basis point average during 2004, 2005, 2006, 2007 and the first half of 2008.

According to Scott Grannis:

Inflation expectations have been slowly working their way higher all year, and it shows up in the combination of declining real yields on TIPS, as demand for TIPS's inflation expectation increases, and rising nominal yields, as demand for unprotected bonds declines.

I've argued many times this past year that the bond market is not the best place to go looking for signs of inflation. That's because the bond market is heavily influenced by what the Fed says and does, and the Fed is not always right about the direction of inflation. Bonds (and the Fed) tend to be late to the inflation or deflation party, and that's one way that inflation or deflation feeds on itself.

So while the bond market's inflation expectations have increased substantially this year, it is not really sending any warning signals about inflation.

The current WSJ consensus forecast for inflation in June 2010 is 1.8% (with outliers Mark Nelson forecasting 4.7% and Brian Wesbury/Bob Stein forecasting 3.6%) and 1.8% again for December 2010 (with Nelson at 5.2% and Wesbury/Stein at 3.8%).